Controlling the RMB Group 1 Day 5 Chia-Hung Chen Pauline Tsai

 If you control the oil, you control nations.  If you control food, you control people.  If you control money, you control the world. by Henry Kissinger

Until the mid-1990s, foreigners in China could only purchase goods and services with foreign exchange certificates (FECs). FECs were phased out in 1995 as Beijing began to open up.

⌾Now China is the world's 2nd largest economy, biggest exporter and manufacturer in the world ⌾ The RMB is the world's 5th most-used payment currency ⌾ 27 percent of China's total goods trade is now settled in RMB yet China exercises tremendous capital control including restrictions on RMB.

 China first established RMB convertibility for both trade and investment as a long- term goal in  The world is expecting China to establish a freely convertible capital account, but what China is heading to managed convertibility.  Having passed through many years of reform, currently China is already not too far from its goal.

What Is Currency Control?  A system whereby a country tries to control money within its borders. From simple to complex policy changes, it can be characterized as a government initiated system to control currency fluctuations through interest rates, bonds, laws, money printing, and many more.

Why China Controls RMB?  China’s growth depends largely on exports, and low China’s currency makes its exports cheaper.  The exchange rate policy is required to sustain a high growth rate.  A stable exchange rate eliminates part of the exchange rate uncertainty for Chinese exporters and importers and their trading partners.  China believes that an orderly opening of the domestic financial market to international capital transactions could solve many of the problems facing China’s financial system.

China’s Exchange Rate Policy  China decided starting from the Asian crisis in to keep its currency fixed versus the value of the US dollar. It did so until July  It then switched to a managed float of USD/RMB, where the value of the RMB gradually increased versus the US dollar (thus, USD/RMB gradually declined).  In the course of three years, the RMB strengthened by as much as 21% versus the US dollar.

 Here is a snapshot of the value of RMB against US dollar. For a time before 2006, the exchange resembled a flat line. Ditto between 2008 and This is what a fixed exchange rate looks like

History of trading band widening ⌾Mar /- 2% ⌾ April /- 1% ⌾ May /- 0.5% ⌾ Jul 2005 (unpegged) +/- 0.3% From March 2014 onwards, daily fluctuations in USD/RMB are a maximum of 2.0%

IS RMB undervalued as believed? Chinese purchasing power may be overstated, because environmental regulations, labor standards, food & drug regulations……are much less reflected in Chinese produced goods than American produced goods. Not much of a safety net is implied in the price of Chinese goods, which also results in a higher Chinese savings rate. Consequently, Chinese exports to the US are too cheap and American exports to China are too expensive.

China’s Progress  The RMB is already much more convertible than many think. Only 4 out of 40 items under the capital account are non-convertible. Further easing of restrictions on cross-border investment and currency transactions plus expansion of the qualified investor’ programmes should lead to a breakthrough in convertibility in  Beijing is determined to push forward with full liberalisation of the RMB.

China’s Progress (cont’d)  On May 26, The IMF, after ending its evaluation on China's economy, said the RMB over the past year has seen its real effective exchange rate (REER) appreciate sharply, signaling that the currency is no longer undervalued. This is the first time the IMF has not judged the RMB to be undervalued, indicating that the currency has a good chance of being included in the SDR currency basket in November.

conclusion

Is China’s Currency control necessary?  As of July 1, 2015, China’s population is 1,402,871,348. For each decision, China Gov. has to bear all those people in mind.